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Bank Recapitalization Inadequate Debt Crisis Solution?

Plans to force Europe’s banks to increase their equity capital to ensure they can withstand the worsening euro zone debt crisis and restore confidence in the sector have been met with criticism from analysts and business leaders, who fear the proposals will lead to dilution for shareholders and a further backlash.

European Commission President Jose Manuel Barroso on Wednesday said the EU “urgently” needed to strengthen banks, warning that sovereign debt contagion and the banks were now undoubtedly linked.

Fears that Greece in particular but also countries like Italy and Spain may default on their debts have hit banks particularly hard in recent weeks, culminating in the rescue of Franco-Belgian bank Dexia which is heavily exposed to Greek sovereign debt.

The International Monetary Fund has estimated that banks could face a capital shortfall of as much as 200 billion euros.

But a broader European bank recapitalization will not solve the regions problems, critics argue.

“It looks like capital will be put into the system, regardless whether a specific bank needs any additional capital or not,” Rainer Skierka, Equity Analyst at Sarasin wrote in a note to clients.

Such a move would lead to governments taking a stake in the continent’s banks, which Skierka warned would lead to “massive dilution for shareholders”.

“The market would likely react negatively and conclude that another opportunity had been missed to fix the problem,” he said.

“We don’t think that a general bank recapitalization is a good idea.

Some banks, like the Greek need lots of core equity, while other banks remain well capitalized to absorb any potential losses.

What banks need more urgently is the absence of rumours of default risk in Italy and Spain,“ he added Spain – due to its size- has been a particular cause for concern.

Although the country is considered solvent, Spanish bond yields have been driven up amid concerns over the country’s budgetary challenges.

“It is true that we have a strong reduction in the construction sector – construction represents 60 percent of GDP – but if you take out this the rest of the economy is doing well and growing by 2.6-2.7 percent.” Baldomero Falcones, Chairman & CEO of Spanish construction group FCC told CNBC.

He pointed out that public debt in the case of Spain is 67 percent of GDP, 20 percent less than the European average and 30 percent less than the US.

The issue appears to be confidence, rather than capital.

“Capital, in general, is not the core of the issue.” Skierka said.

“While in the past regulators have recapitalized banks for a double-dip recession, no practical amount of capital injection can prepare the sector for large sovereign impairment or default,” he said.

His comments echoed those made by Deutsche Bank CEO Josef Ackermann on Thursday.

Ackermann said it was doubtful whether a recapitalization of European banks would help stem the sovereign debt crisis.

"It's not the capital position which is the problem, but the fact that sovereign debt as an asset class has lost its risk-free status," Reuters cited Ackermann as saying.

Contact Europe: Economy

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